Gaming HUI Corrections 2

September has been a brutal
month for commodities investors. While the oil and natural gas
routs have garnered most of the financial media attention, the
bloodshed is much more widespread. Since September 5th gold
has fallen 9.6% which has spawned a sympathetic 20.5% plunge
in the HUI gold-stock index.

A freefall approaching 21%
in only 11 trading days would drive phenomenal pain in any index,
but the psychological damage just wrought in the HUI has been
exceptional. After all, on the very eve of this carnage-laden
plunge the HUI surged to 365, its highest level since its latest
May interim top. But just two weeks after this bright ray of
hope, this flagship gold-stock index is suddenly wallowing in
the mud near 290. Riches to rags.

Many gold-stock investors who
eagerly watched the HUI carve a series of sequentially higher
lows in recent months are now walking around like the
living dead, shell-shocked and devastated. Sentiment has fallen
off a cliff to new lows. For the first time in over a year,
this past week I started receiving e-mails wondering if the gold
bull is over. How could a sector execute such a sudden turn-one-eight
after trending higher for months?

I believe the answer to this
question is simple, the HUI's correction from its stellar May
top is still ongoing. A lot of gold-stock traders chose
to believe that the blistering 31% decline over 23 trading days
from May 10th to June 13th was the entire correction. They believed
a new upleg in the HUI began in mid-June so they stopped worrying
about lower HUI levels. For a variety of reasons though, this
rosy thesis was problematic.

The sole purpose of corrections
is to rebalance sentiment within an ongoing bull market. They
exist to eradicate the greed that becomes ubiquitous and smothering
near major interim tops like the one we saw in the HUI in May.
Even at its deep June lows, since that plunge happened so fast
no really negative sentiment had time to gain a foothold and
blossom. The HUI then started rallying again so fast in mid-June
that there was not enough time for fear and apathy to roll in
like a fog and taint traders' gold-stock perceptions.

The one non-negotiable prerequisite
for a major interim bottom to be carved is for traders to be
paralyzed with fear, doubt, apathy, and even loathing for a suddenly
out-of-favor sector. A great illustration is oil stocks today,
suddenly investors would seemingly rather hold plague-bearing
rats than oil stocks. Such depths of despair never wrapped their
icy black fingers around the heart of the HUI since May, even
during the June lows. Until 300 failed over this past week,
fear remained conspicuous in its absence in the HUI correction.

Now it is easy today
to claim that the HUI correction never ended this summer despite
overwhelming enthusiasm to the contrary. It was infinitely harder
to make this claim in recent months as the HUI climbed from June's
274 lows to early September's 365 highs. While this promising
33.5% run ultimately proved to be merely a suckers' rally, many
if not most gold-stock investors believed it was a new upleg.
It was horrendously unpopular to be neutral on the HUI, claiming
it was still correcting, during this particular rally.

Yet at Zeal we steadfastly
held to the correction thesis because that is what the technicals
were telling us. In early August as the HUI challenged 350 I
wrote the following in the August Zeal Intelligence, which explained
in depth why probabilities overwhelmingly favored the HUI's correction
not being over yet

"Since I bought in too
early initially in each of the last two major HUI corrections,
I'm not taking the potential trickiness of this one lightly.
Corrections are tricky by design, full of surprises that are
designed to seduce in the unscarred and obliterate their scarce
capital. I'm only neutral on the HUI now because I bear so many
scars, and losses, from past HUI corrections and I have not forgotten
what cunning adversaries they are. Take this seriously!"

Even back on June 23rd when
the HUI had already bounced sharply higher by 13.9% off of its
lows of less than two weeks earlier, it was apparent the HUI
correction was almost certainly not mature enough to already
be over. In the original "Gaming HUI Corrections"
essay back then I wrote

"Since the HUI fell so
hard so fast this time around, thankfully the vast majority of
its correction in percentage terms is probably behind us. Yet
in the time-duration terms crucial to rebalance sentiment, it
remains very young. I suspect the odds favor it meandering generally
sideways to lower in a consolidation in the coming months. Upside
potential is low but downside risk isn't extreme either since
multiple technical approaches point to a 255ish probable bottom."

I offer up my earlier analyses
to prove that there were actually contrarian students of the
markets out there who have been warning continuously since June
that the odds were very high that the HUI correction was not
yet over. As detailed in our Zeal essays, newsletters, and
alerts published since then, the HUI technicals never looked
right for a major interim bottom since the May highs. Major
bottoms have specific technical signatures which we simply had
not witnessed yet this time around.

But today, thanks to the sharp
HUI plunge in September, things are finally looking up. Rather
than traders seeing dollar signs when they think of gold stocks,
now they are getting scared. They are questioning the entire
premise of this bull, they are extrapolating the recent downtrend
to much lower lows than we've just seen, and they are getting
scared. In the movie Wall Street, Gordon Gekko was wrong,
it is fear that is good, not greed. It is fear that marks
the very best buying opportunities in any ongoing secular bull
market.

The primary reason I held fast
to the notion that the HUI's latest correction did not end in
June despite the summer strength in the index was its bull-to-date
precedent. Over time bull markets tend to establish rhythms.
Greed drives major uplegs to dazzling new highs, but by the
time those highs are reached sentiment is way out of balance.
So corrections subsequently ensue to bleed off the greed and
restore balance. Once the sentiment pendulum swings the other
way and fear takes the place of greed at major interim lows,
the way is clear for the next major upleg to start powering higher.

This latest update of the HUI
bull-to-date rhythm chart illustrates how this sentiment mechanic
has unfolded in the HUI since its enormous 996% bull market was
born almost six years ago. I believe this is one of the single
most important charts for gold-stock investors and speculators
to internalize. It does wonders in setting realistic expectations
about probable HUI behavior in both major uplegs and corrections
to come.

So far in its amazing bull
market, the HUI has had six major uplegs and six major corrections.
In secular bull markets both of these primary phases of market
activity are equally important. The periodic single steps back
in corrections are absolutely and completely necessary in order
for the next double steps forward to occur in uplegs. No bull
market ever rises in a straight line and neither does the HUI.
To expect anything less than periodic corrections is totally
irrational and will lead to losses.

The HUI's six major uplegs
so far have yielded an average absolute gain of 104% each over
156 trading days! To the best of my knowledge no other sector
has even come close to seeing such recurring 100%+ gains over
the past six years. These breathtaking upleg gains illustrate
why the gold stocks remain the most popular commodities-stock
sector among investors and speculators. Gold stocks have really
walked the walk.

While everyone loves to wax
ecstatic about the magnificent gains with which we have been
blessed in the HUI uplegs, few like to talk about the other side
of the coin. Major corrections have happened after every
single major HUI upleg without exception. Corrections
after uplegs are as inevitable as night following day. But just
as night never lingers eternal, neither do corrections. The
five major HUI corrections before our current one have averaged
30% absolute losses each over 88 trading days.

It was this particular metric
that made me wary in June when I wrote my original essay in this
series. HUI upleg 6, which just ended in May, was the second
largest witnessed in this entire bull market. After big uplegs
usually come big corrections, there tends to be some symmetry
between greed and fear in a particular upleg/correction cycle.
The only other uplegs comparable to 6 in magnitude were 2 and
4. I consider all three of these to be "massive" uplegs.

It is intriguing that the HUI
uplegs have carved a binary pattern since 2001. There will be
a massive upleg, with gains between 125% to 145%, followed by
a particularly ugly correction. This massive upleg will drive
the HUI way up into new territory to radical new bull-to-date
highs. But after these dazzling new highs are achieved, traders
aren't quite comfortable with them yet. In the next uplegs after
massive uplegs, the HUI usually fails around the previous massive
upleg's top. I call these in-between uplegs "consolidation"
uplegs.

Although market patterns can
always change at any time, over the past five years the HUI's
uplegs have run in a massive-consolidation pattern. Uplegs 2,
4, and 6 were massive uplegs while uplegs 3 and 5 were consolidation
uplegs with gains less than half of the massives' gains. Back
in June I realized that the corrections following massive uplegs
2 and 4 averaged 35% losses. This made me wary of correction
6's relative lack of progress at that time.

From May to June, the HUI fell
31% in 23 trading days in major correction 6. But after the
second biggest upleg of this entire bull market, 31% seemed a
bit light compared to the 35% average after the first two massive
uplegs. While this was somewhat problematic, I could live with
it and even concede that in depth terms correction 6 had pretty
much hit expectations. After all, the average loss in all five
major corrections before it was 30%.

But the far more troublesome
component was correction 6's trivial duration at the time. Major
corrections exist to destroy greed and they do so over two dimensions,
depth and duration. The most effective corrections attack greed
simultaneously on both fronts, falling substantially to eviscerate
enthusiasm and then grinding sideways to new lows over many months
to utterly destroy hope among the deployed and create apathy
among the undeployed. Correction 6 had no duration element,
it had only lasted for 23 short trading days.

How short is 23 days relative
to the HUI's bull-to-date precedent? Ridiculously short! The
average duration of the first five major corrections was 88 trading
days. Back in June the HUI's correction was only about one-quarter
of the way to the point in time where its correction was expected
to mature to in duration terms. Correction 2's 36% decline over
37 trading days made the young correction 6 look even more suspect.
Even though it occurred after the biggest and most powerful
upleg of this bull it still took 60% longer than the young correction
6.

With correction 6 back in June
failing to even remotely parallel the HUI's bull-to-date correction
precedent, the only technical conclusion to reach was that it
was almost certainly not yet over despite the sharp rally.
This unpopular view was bolstered by the fact that it was so
detested, that virtually everyone wanted to believe that a new
HUI upleg had erupted in June. There was no fear. At real fear-laden
bottoms traders get so beaten down that they cease to even
look for a bottom. But back in June it was universally believed
to be the bottom.

If correction 6 was to at least
make a semblance of following its predecessors, then the only
prudent course of action to take back in June was to be neutral
on the HUI and expect a further consolidation and correction.
So that is exactly what we did at Zeal. While this stance was
extremely unpopular and generated an unbelievable amount of flak
for us this past summer, we were vindicated in the last couple
weeks. Corrections take time to unfold because greedy sentiment
cannot be eradicated overnight.

This brings us to today. For
the first time since summer 2005, the technicals for the HUI
are actually starting to look really bullish again thanks to
the early-September carnage! The correction that was only 23
days old in June is now a mature consolidation that has been
running for 92 trading days, actually above the 88-day
correction average. Fear is finally returning to the HUI, a
very bullish development, because correction 6 has finally lingered
long enough to start shaking the faiths of even longsuffering
gold-stock investors.

With correction 6's duration
finally mature, in pure duration terms this correction can now
end anytime having nearly accomplished its sentiment-rebalancing
goal. This is wonderful news and very exciting. The one remaining
loose end is depth. While the depth dimension of this
correction certainly could be done, there are several technical
perspectives that suggest we may have a little further to go
yet.

With an average correction
falling down 30%, correction 6's 31% decline as of mid-June is
sufficient to slightly exceed average. This is the key piece
of rhythm evidence suggesting that June's 274ish HUI lows might
just hold here. While this may prove to be the case, it is important
to consider the contrary evidence as well. It all points to
a slightly lower major interim low in the HUI than the levels
we saw in June.

First, our latest upleg 6 was
massive. After massive uplegs 2 and 4, the only comparables
to 6, the HUI corrected 35% on average. If correction 6 follows
the precedent of post-massive-upleg corrections 2 and 4, then
we could very well see another 35% May peak to whenever trough
decline. This yields a 255ish bottoming target for the HUI.
Lest you think this is new spur-of-the-moment thinking, I said
the exact same thing in June, "A 35% HUI correction off
the early May highs would drag this index down to 255ish."

Second, during each of its
last two major corrections, 4 and 5 above, the HUI fell to levels
just under 0.80x its 200-day moving average. You can see the
blue HUI line cross well under its black 200dma line above in
corrections 4 and 5. As of this week, the lowest the HUI has
traveled relative to its 200dma in correction 6 was only 0.90x.
At today's 200dma, the HUI would again have to see 255ish if
it fell fast to 0.80x relative. This concept isn't new either,
I discussed the 0.80x rHUI bottoming levels in the June 2006
Zeal Intelligence.

Third, there is a fascinating
Fibonacci retracement tendency in corrections after massive HUI
uplegs, which I again discussed in my original essay back in
June. Here is an updated version of that earlier chart.

It indexes each of the three
massive uplegs in the HUI individually with 0 being their starting
points and 100 being their tops. Then the duration of each upleg
in trading days running before and after each top is rendered
on the X-axis. The tops are synchronized to the day, at day
zero, so each massive upleg/correction can be analyzed relative
to its peers. The goal of this hybrid chart is to consider each
massive upleg and subsequent correction in perfectly comparable
terms.

The blue line below is our
latest massive upleg and correction indexed. Back in June's
essay I drew in the shaded blue area which I thought was the
probable consolidation range. While the shape of the range wasn't
too far off, the consolidation started higher than I'd expected
since the HUI kept rallying into July. Nevertheless, today we
find ourselves right back in this probable consolidation range
and still above the precedent floor.

Rather than starting trading
sideways in late June as I'd expected at the time, the HUI instead
continued rallying sharply higher and then entered a high consolidation.
High consolidations are especially deadly as they create the
most false hope. With the HUI running between 310 to 350 or
so most of this summer, which wasn't all that far below the 394
May highs, it was really hard for traders to believe that we
were still in a young correction. Yet hope in a correction is
always dashed on the rocks by the time it fully runs it course.

Interestingly this past summer's
high consolidation mirrors, almost perfectly over the month or
so prior to the HUI's early September highs, the high consolidation
of massive upleg 4, the red one. Back in early 2004 correction
4 started out rather slowly and just grinded sideways, convincing
many people including me unfortunately that the worst was behind
us. Then at the very end of this correction it fell off a cliff
and shredded anyone who bought in too early. Correction 4 really
hurt a lot, believe me!

Now today correction 6 is mirroring
correction 4 incredibly well. The HUI hit 365 and created its
last hurrah of false hope on the 81st trading day of our current
correction. Back in correction 4, the HUI's last minor high
was achieved on the 83rd day. And then after that the bottoms
fell out of both corrections and they started plummeting. While
I don't know if this uncanny symmetry will continue, I'd be hesitant
to bet against it.

Why? Correction 2 and correction
4 both ended at the same indexed level, just above 38. For you
mystics, this 38.2 potential major-HUI-correction floor is a
classic Fibonacci number as I discussed in depth in June. It
is pretty extraordinary that the two very different major corrections
following massive uplegs 2 and 4 both ended right near 38.2%
of the way from the bottom to the top of their respective preceding
uplegs. Only time will tell, but there is certainly a possibility
that our current correction 6 will be drawn to this 61.8% retracement
as well.

So what is the HUI level 61.8%
of massive upleg 6's height below its top and 38.2% of its height
above its bottom? 255ish! Obviously 255 continues to crop up
all over the place from varying technical perspectives which
should really cause us to take notice.

As a mere mortal who cannot
see the future, I certainly do not know when and where the HUI
will bottom. But since its latest major correction has finally
reached a mature duration, the when could be anytime in the coming
month or two. Based on the analysis above, the where could be
any level between around 275 down to 255 or so. Neither is very
far away from here!

This is very exciting as it
means we are finally getting close to our next major buying
point to add new long positions ahead of the next major gold-stock
upleg. At Zeal we have been patiently preparing for this crucial
inflection point all year. Back in May after many months of
fundamental research we wrote and published a comprehensive report
detailing our favorite 20 gold stocks for the next upleg, the
coming upleg 7.

And we will be carefully watching
gold and HUI technicals in the coming months and launching new
gold-stock trades in highly-promising elite stocks as appropriate.
If HUI precedent holds and its secular bull continues, we are
on the verge of one of the best buying opportunities of this
entire bull. Please subscribe today to our acclaimed monthly
Zeal Intelligence newsletter so you don't miss our coming gold-stock
trades!

The bottom line is the HUI,
after many months of creating false hope this past summer, is
finally nearing the point where its next major interim low is
probable. Just as this past June when no one was scared was
the time to be wary, today when everyone is scared is the time
to get excited. If the secular gold and HUI bulls are still
on course to power higher, then the interim low ahead of major
upleg 7 is probably rapidly approaching.

All bull markets flow and ebb,
follow rhythms established over time and driven by sentiment.
It is very exciting to once again be reaching the moment in
time in the HUI when its current ebb is likely to bottom out.
For all of you prudently and patiently waiting for the first
great buying opportunity in gold stocks since summer 2005, it
looks like your patience is finally going to pay off. Congratulations!

Adam Hamilton, CPA

September 22, 2006

Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!